GI Research Macro and Financial Market Outlook...FOR PROFESSIONAL INVESTORS ONLY Working with you since 1831 GI Research Macro and Financial Market Outlook July 4, 2017 Dr. Martin

FOR PROFESSIONAL INVESTORS ONLY

Working with you since 1831

GI Research Macro and Financial Market Outlook

July 4, 2017

Dr. Martin Wolburg, Senior Economist


French relief rally, fading “Trump trade” weighs on US yields and the US dollar

2

FINANCIAL MARKET REVIEW

1800

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07/15 10/15 01/16 04/16 07/16 10/16 01/17 04/17

Equitiesdaily basis

MSCI EMU S&P500 (rhs)

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Foreign exchange ratesdaily basis

USD/EUR JPY/USD (inv. scale, rhs)

stronger USD

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Yield on 10-year Government Bondsin % p.a., daily basis

Treasuries Bunds (rhs)

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07/15 10/15 01/16 04/16 07/16 10/16 01/17 04/17

Euro area spreadsover Bunds, in bps, daily basis; corporate spreads: IBOXX

IG Euro Corporates Non Fin. IG Euro Senior Financials

Southern European sovereigns* * weighted avergage


Solid economic data to help markets navigate through remaining political risks

EXECUTIVE SUMMARY

Main Risks

Global Macro The sweep victory of French president Macron’s party in general elections has turned Frexit fears into reform hopes.

Policy risks remain (US on tax reforms, Italy on snap elections/hung parliament), but the continued solid global macro backdrop will help financial markets to weather these risks.

Inflation rates still struggle to increase in the advanced economies, but we anticipate a gradual increase in core inflation for the US and the euro area over H2.

Monetary Policy The Fed hiked rates by 25 bps in June. In September, the Fed may well announce details on

how to gradually reduce its balance sheet. We anticipate further increases by a cumulated 100 bps by year-end 2018, more than twice as much as currently priced by markets.

The ECB has adopted a less accommodative forward guidance, preparing the way for a September announcement of QE tapering. The BoJ will stick to its yield curve control targets.

Financial Markets Solid economic data and a prospective less accommodative ECB stance to keep upside

pressures on Bund yields intact. Southern European sovereign spread tightening has likely largely run its course, due to looming ECB tapering and the risk of a political gridlock in Italy. US Treasury yields to rise gradually amid a strong labor market and a tighter Fed policy stance.

Equities in the EA and Japan likely to deliver low positive total returns. High valuations and pressures on margins limit the upside for US equities.

Impasse on tax reform in the US. Fed rate hikes and concerns about ECB QE tapering trigger a strong spike in yields. Political gridlock after next general elections in Italy.

3

Asset Allocation Overweight in equities (Japan, euro area) and euro area credit. Underweight and short duration on euro area and US government bonds.


Global economy in robust expansion despite high policy uncertainties, underpinned by

− solid consumption,

− investment pick up in the advanced economies.

Global trade has been recovering, too, both in terms of volume and US dollar demand.

Early 2017 soft patch in US to be followed by moderate growth acceleration in H2.

EM growth stable, with controlled slowdown in China offset by recoveries in Brazil and Russia.

Fading capital outflows, more stable oil price and lower real rates to help support EM growth.

Overall, global growth to pick up to 3.4% this year (from 3.0% 2016).

Global economy to stay resilient despite unusually high policy uncertainty

4

1. GLOBAL GROWTH RESILIENCE SET TO CONTINUE

-2.0

-1.0

0.0

1.0

2.0

3.0

4.0-4.0

-3.0

-2.0

-1.0

0.0

1.0

2.0

2000 2002 2004 2006 2008 2010 2012 2014 2016

Business confidence and political riskstandardized indicators, average of US, euro area and China

Business confidence Policy uncertainty (rhs inverted)

higher business

confidence

rising political risk

-4.0

-2.0

0.0

2.0

4.0

6.0

8.0

10.0

2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019

Actual and projected global growthGDP, % yoy

Advanced economies EM & Developing economies World

forecast


GDP growth is set to rebound in Q2 driven by brighter prospect for capex speding, adding to solid household spending.

The economy is strong enough to sustain 2.2% growth this year, without any fiscal stimulus.

Political uncertainty to delay/soften fiscal boost. It will start having an effect in 2018 at earliest, likely allowing for above 2% growth also next year.

Labor market continues to tighten, and supply constraints start weighing on payroll growth after a record-long expansion.

After a temporary setback, core inflation will restart its upward trend.

Fed to hike rates once again by year end. Further tightening in 2018 still underappreciated by markets.

In September, further details on the balance sheet shrinking to be communicated in order to prepare markets and ensure smooth transition.

Tight labor market to keep the Fed on course, looking through temporarily lower inflation

5

2. US: SOLID OUTLOOK DESPITE POLITICAL UNCERTAINTY

0.000.250.500.751.001.251.501.752.002.252.502.753.003.25

06/17 10/17 03/18 07/18 11/18 04/19 08/19 12/19 04/20 08/20

US Key Rate Expectationsin %

OIS markets, 29/6/2017 OIS markets, 30/12/2016

GI Research Fed dots June '17

4

5

6

7

8

9

10-900

-700

-500

-300

-100

100

300

500

11/90 05/93 11/95 05/98 11/00 05/03 11/05 05/08 11/10 05/13 11/15

US labor marketpayrolls as monthly changes

Non-farm payrolls 12mma Unemployment rate (in %, rhs, inv.)


Q1 2017 real GDP up by +0.6% qoq on the back of strong domestic demand, record-high sentiment implies that Q2 2017 is of similar strength.

Looking ahead:

− Consumption activity dampened by inflation in an environment of low wage growth and an already low savings rate…

− … but stronger investment activity on the back of high cap. utilization and a favorable outlook to largely compensate for this in the quarters ahead.

Growth outlook revised up to 2.0% in 2017 (from 1.7%) and 1.6% in 2018 (from 1.4%).

Headline inflation to stay around 1.5% yoy in the months to come. Core inflation to only slowly trend up (1.2% in 2017, 1.4% in 2018).

With forward guidance in place the ECB will intentionally “fall behind the curve”, with a first key rate hike not before the end of QE.

Base case: Tapering to start in January 2018 and to end in September 2018.

Shift in domestic demand from consumption towards investment to keep growth strong

6

3. EURO AREA ACTIVITY TO STAY FIRM

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0.00

0.10

0.20

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0.60

0.70

Drivers of Growthcontribution to qoq euro area GDP growth, pps

Consumption Investment

forecast

-0.40

-0.35

-0.30

-0.25

-0.20

-0.15

-0.10

-0.05

0.00

0 3 6 9 12 15 18 21

ECB monetary policy expectations3-month Euribor in months ahead implied by OIS

30/06/2017 26/06/2017

Before Draghi speech on June 27


Following the election of Macron as President, his party also got an absolute majority in the National Assembly.

Macron announced to substantially reform France and vitalize growth. Three major fields of reforms:

− Labor market reform towards a “Nordic Model” (working time regulations, wage setting, training).

− Fulfill target of Paris Climate Agreement. Investment of around 1% of GDP p.a. to ensure energy transition in housing, transport and agriculture.

− Foster digital revolution and employ domestic sources of finance.

Moreover, liberalization of the housing market, reform of inheritance tax, simplification of the tax system, reform of education and pan-European investment plans are on the agenda.

There will likely be stiff public resistance – especially from trade unions – but pushing through these reforms would lift long-term growth.

France: From Frexit concerns to reform hopes

7

3. EURO AREA ACTIVITY TO STAY FIRM

0.00

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0.60

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0.80

FR/DE-Spread10Y government bond yield spread, pps

10Y average: 0.43


8

3. EURO AREA ACTIVITY TO STAY FIRM Macro fundamentals improved in Southern Europe but political risks still high

The case for Southern Europe and Greece

PORTUGAL: Growth momentum gains pace Economy embarked on a recovery track, rating outlook improved High approval for current left coalition; general elections in 2019 High debt, poor demographics and incomplete clean-up of bank’s balance sheets a longer term risk SPAIN: Mind risk of a new government and Catalan issue Real GDP growth to soften mildly, but from very elevated levels Improvement in competitiveness but only slowly in public finances Risk that opposition leader succeeds and forms a new government; Catalan issue a potential for woes ITALY: Growth largely rests on consumption, elections 2018 ahead Italy joins recovery track but consumption still main driver Ongoing problems to achieve deficit targets, banking sector woes General election in 2018 to bring strong gains for euroskeptics GREECE: Turnaround achieved but debt cut still far away Greece embarked on a recovery track Impressive fiscal consolidation in 2016, aid program to last until 2018 Further debt relief measures ahead but debt cut not on the horizon

-3.0

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05/07 05/08 05/09 05/10 05/11 05/12 05/13 05/14 05/15 05/16 05/17

Peripheral Economic Confidencez-scores of monthly EC Economic Sentiment Indicator

ES GR IT PT

8.5 8.3

4.7

2.61.9 1.7

0.8

-0.4 -0.6 -0.9 -1.1-2

0

2

4

6

8

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NL DE IE IT ES AT PT BE GR FR FI

Euro area current account balancecurrent account balance, % of nominal GDP, 2016

Euro area


Probability of a snap vote down to 15% following:

− The collapse of the 4-party deal over the new electoral law emerged in late May and the postponement of the negotiations to find a new agreement to September.

− The poor showing of the Democratic Party (PD) and the Eurosceptic Five Star Movement (M5S) in the recent local elections.

The probability of a snap vote in late September will keep falling unless a last-minute deal on a new electoral law emerges before the summer recess.

While the vote has been likely postponed to H1 2018, opinion polls point to a hung parliament:

− Eurosceptic forces would fall just short of 50% of seats in both chambers.

− Unprecedented coalitions among all pro-EU parties would be necessary to overcome the very likely hung parliament.

The economy is currently benefitting from the solid global growth momentum and the loose fiscal policy. However, fiscal consolation in 2018/2019 will likely lead to a slowdown.

Snap election in late September less likely, but polls point to political paralysis after vote

9

4. ITALY: POLITICAL UNCERTAINTY TO PERSIST

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Sen

ate

Low

erC

ham

ber

Italy: Parliamentary seats projectionsin % of total seats, based on last 10 polls (Jun 21-30).

"Leftists" = MDP, CP and SI, Eurosceptic parties: M5S, LN, FdI

Leftists PD FI AP Other pro-EU LN FdI M5S

Weighted average of 5 scenarios: 1) no coalitions (10% prob.) 2) LN+FdI coalition only (30% prob.), 3) LN+FdI and Leftists coalitions (40% prob.), 4) LN+FdI+FI and Leftists coalitions (15%

prob.), 5) center-right and center-left coalitions (5% prob.). AP has 40% prob. to exceed 3%.

Eurosceptic partiespro-EU parties

-1.5

-1.0

-0.5

0.0

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2.0

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2014 2015 2016 2017

Italy: Real GDP breakdowncontribution to yoy growth, in %

Cons. spending Gov. spending Fixed investmentsNet exports Residual Real GDP


Long-dated US and euro area yields have been in a range for more than half a year.

This is unlikely to continue on a medium-term horizon due to:

− Underlying price pressure to increase (particularly in the US). US inflation expectations distorted by recent (temporary) weakness.

− Fed to hike four times until the end of 2018 and to start shrinking of balance sheet (less than two hikes are currently discounted).

− Economic rebound to continue on both sides of the Atlantic for the time being.

− US traders positioned for lower yields (contrarian indicator).

ECB’s QE to limit the increase in euro area core yields as scarcity of German Bunds will remain an issue.

All in, US and euro area yields to rise across the curve going forward. Transatlantic yield spread to widen moderately.

Way is paved to higher core yields on both sides of the Atlantic

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5. GOV. BONDS: UNAPPEALING GIVEN LOOMING YIELD INCREASE

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1

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3

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12/15 02/16 04/16 06/16 08/16 10/16 12/16 02/17 04/17 06/17

Transatlantic Yield Spread10-yr benchmark bonds

Spread: US/euro area Euro area, in % (rhs) US, in % (rhs)

1.9

2.0

2.1

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10/16 11/16 12/16 01/17 02/17 03/17 04/17 05/17

10-year Inflation Expectationsderived from inflation swaps, in %

Euro area US (rhs)


Peripheral bond spreads have tightened in recent months and are currently on the lowest level since January.

Going forward, development is expected to be weaker:

− Italian elections will take place at latest in H1 2018, risk of a hung parliament is high. Markets too complacent regarding future policy uncertainty.

− ECB to announce an exit strategy in Q3, loss of an important support factor not yet priced.

− Structural weakness in some European countries unlikely to be tackled.

− Increase in underlying yields reduces demand for higher yielding (but riskier) assets.

Snap elections in Italy remain a risk scenario which could trigger an even stronger spread widening in the short term, but low level of debt held abroad shields somewhat.

Current low spread level unlikely to prevail. Italian BTPs to underperform Bonos in the months to come.

Political news flow to burden Southern European government bond spreads

11

5. GOV. BONDS: UNAPPEALING GIVEN LOOMING YIELD INCREASE

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Econ. Policy Uncertainty and Gov. Spreadsin bps to German Bunds, monthly data, 10-year bonds

Weighted average of Ireland, Italy, Portugal, SpainEuropean Economic Policy Uncertainty Index

0

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10-year Sov. Spread Euro Area Peripheralsin bps to German Bunds, daily data

Ireland Italy Portugal Spain Greece (rhs)


Euro area corporates have performed well in recent months, particularly the low volatility is remarkable in politically troubled times.

Short-term outlook remains favorable:

− Economic rebound to continue, keeping defaults on an extraordinary low level.

− Sound situation and healthy balance sheets of corporates.

− Positive net issuance balanced by inflow in this asset class.

− Flexible ECB purchases to remain a positive factor for the time being.

Longer-term, some spread re-widening:

− ECB tapering to start in Q1 2018.

− Increase in underlying yields to take the gloss of corporates.

− Potentially high leverage to impact balance sheets.

However, even in the long run only very moderate spread widening (and yield increase).

Constructive on a short-term horizon, in the longer run some spread widening

12

6. CORPORATE BONDS: SOME VALUE LEFT VS. CORE GOVIES

0

100

200

300

400

500

600

-1.0

0.0

1.0

2.0

3.0

4.0

5.0

6.0

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8.0

9.0

06/07 06/09 06/11 06/13 06/15 06/17 06/19

iBoxx Euro Area CorporatesAll maturities, yields in %, spreads in bps

5-yr Bund yield iBoxx corp yield iBoxx corp spread (rhs)

Forecasts

100

120

140

160

180

200

220

0.6

0.8

1.0

1.2

1.4

1.6

1.8

2.0

31/12/14 30/06/15 31/12/15 30/06/16 31/12/16

iBoxx Euro Area CorporatesAll maturities

Yield (in %) Duration adj. spread vs. Bunds (in bps, rhs)


Short-term, the euro looks vulnerable to a setback from the recent rebound due to

− disconnect from yields

− strong speculative swing

− underpriced Fed tightening

Medium term, however, we look for a stable to gradually stronger EURUSD underpinned by

− tapering announcement by ECB expected for September

− current account differentials (deficit in US, surplus in euro area)

− moderate recovery in oil price (helping euro)

We anticipate USD hedging costs to increase further in the wake of rising US rates and continued very low rate levels in the euro area.

Despite risk of setbacks in the short term, euro to prove resilient vs. US dollar

13

7. CURRENCIES: A BOTTOMING EURO

1.00

1.10

1.20

1.30

1.40

1.50

1.60-2.0

-1.0

0.0

1.0

2.0

3.0

06/04 06/06 06/08 06/10 06/12 06/14 06/16 06/18

Hedging costs of USD exposure

USD 1y hedging costs, in % p.a. USD/EUR (rhs, inv. scale)

forecastrising hedging costs, stronger US dollar

forwards

1.00

1.10

1.20

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1.40

1.50

1.60-2.0

-1.5

-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

2005 2007 2009 2011 2013 2015 2017

Yield differential and USD/EUR

2y yield differential US vs. Euro area USD/EUR (rhs)

Higher US yields, stronger USD


After the strong performance achieved so far (MSCI World +9%ytd), some caution is needed. Risks originate mainly from higher market multiples and in part from increased investors’ complacency.

However, equities are supported by the improved macro environment and earnings growth, a low cost of capital and attractive free-cash-flow yields (5%).

While US equities appear dear, EA and Japanese valuations are not too far from the long-term average. Projected dividend yields and earnings growth back total returns of ~6% on a 12-month horizon.

All in, the good macro momentum should promote rotation into equities. The current funds’ balance of cash is above the historical average.

High political risks and spikes in yield volatility could trigger moderate (and temporary) set-backs. Given the long-term constructive view, they represent buying opportunities.

Decent 12-month total returns ahead, notwithstanding higher market multiples

14

8. EQUITIES: BUOYED BY SOLID GROWTH AND LOW YIELDS

50

100

150

200

250

300

50

100

150

200

250

300

2003 2006 2009 2012 2015 2018

Price and earnings performance

MSCI EMU: 12-month fwd earningsMSCI EMU indexS&P 500: 12-month fwd earningsS&P 500 index

0

5

10

15

20

25

30

35

0

5

10

15

20

25

30

35

1985 1992 1999 2006 2013

PE average: trailing earnings

Avg PE: EMU (IBES index) Avg PE: US (IBES index)US PE EMU PE


Southern European equity markets outperformed the MSCI EMU (+10% ytd) in 2017, with Italy as the only exemption

Looking ahead:

− From a valuation perspective Southern European markets look more attractive than EMU …

− … with GR the only exception as share prices soared by 27% ytd in 2017 so far

− Political risks still present and have the potential to spillover across countries …

− … but given improved fundamentals we deem a resurgence of an outright euro crisis unlikely

All in all, Southern European markets still attractive

Southern European equity markets still attractive

15

8. EQUITIES: BUOYED BY SOLID GROWTH AND LOW YIELDS

-2%

0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

1

EMU vs Southern Europe: valuationaverage premium (>0)/discount (<0)

EMU GREECE ITALY PORTUGAL SPAIN

0.70

0.80

0.90

1.00

1.10

1.20

1.30

Southern European Equity Marketskey stock market index, 31/12/2016 = 1.00

IT ES PT GR


Key financial market forecasts Key macro forecasts

16

Current: 3-day average as of June 28, 2017

APPENDIX: FINANCIAL MARKET FORECASTS

Bonds Current 3M 6M 12M10-Year Treasuries 2.19 2.50 2.60 2.7510-Year Bunds 0.32 0.50 0.60 0.7510-Year BTPs 1.98 2.35 2.55 2.8010-Year OATs 0.68 0.85 0.95 1.10Peripheral SpreadGIIPS 145 155 165 175Corporate Bonds 3M 6M 12MIBOXX Corp. Non Fin 127 125 130 135IBOXX Corp. Sen Fin 114 110 115 120Forex 3M 6M 12MUSD/EUR 1.13 1.12 1.13 1.14JPY/USD 112 114 117 120GBP/EUR 0.88 0.89 0.90 0.90CHF/EUR 1.09 1.09 1.10 1.10Equities 3M 6M 12MS&P500 2433 2431 (-0.1%) 2420 (-0.5%) 2400 (-1.4%)

MSCI EMU 125.4 127.5 (1.7%) 128.5 (2.5%) 129.5 (3.3%)

FTSE 7423 7415 (-0.1%) 7505 (1.1%) 7525 (1.4%)

SMI 9090 9100 (0.1%) 9230 (1.5%) 9170 (0.9%)

TOPIX 1615 1635 (1.2%) 1665 (3.1%) 1695 (4.9%)

Growth2016e 2017f 2018f 2016f 2017f 2018f

US 1.6 2.2 2.3 1.3 2.1 2.4Euro Area 1.7 2.0 1.6 0.2 1.6 1.4China 6.7 6.6 6.3 2.0 2.1 2.3Japan 1.0 1.4 1.0 -0.1 0.5 0.8World 3.0 3.4 3.5 2.3 2.6 2.8f = forecast

Inflation


17

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expressed in this document represent only the judgment of Generali Investments Europe S.p.A. Società di gestione del risparmio and may be

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document does not constitute an offer, solicitation or recommendation to buy or to sell financial instruments. Generali Investments Europe S.p.A.

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gestione del risparmio may have taken, and may in the future take, investment decisions for the portfolios it manages which are contrary to the

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Documents

GI Research Macro and Financial Market Outlook...FOR PROFESSIONAL INVESTORS ONLY Working with you since 1831 GI Research Macro and Financial Market Outlook July 4, 2017 Dr. Martin